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 PAS 2:
INVENTORIES

ABIGAIL N. JACINTO, CPA, MMBM

 INVENTORIES

• Inventories are assets which are held for sale in the ordinary course of
business, in the process of production of such sale, and in the form of materials
or supplies to be consumed in the production process or rendering of
services.
 CLASSIFICATION OF INVENTORIES

1. For merchandising firms

• Merchandise inventory – goods that the company purchases and plans to resell to
customers at a higher price
• Supplies inventory – items that are for store or office use
2. For manufacturing firms
• Raw materials inventory – cost of component parts that have not been used in the
production of goods yet.
• Work-in-process inventory – cost incurred for partially completed items
• Finished goods inventory – goods that have been completely manufactured but have
not been sold to customers yet.
Raw materials Work-in-process Finished goods
INVENTORY RECORD SYSTEMS
 INVENTORY RECORD SYSTEMS

PERPETUAL INVENTORY PERIODIC INVENTORY

SYSTEM SYSTEM
 PERPETUAL INVENTORY SYSTEM

• Cost of purchases and sales are recorded directly in the inventory

account (asset account)
• Freight costs, return of merchandise, allowances given to customers, and
purchase discounts are taken into account in computing inventory cost
• The inventory data are available at any time since the inventory account is
decreased after every sale of goods.
 PERIODIC INVENTORY SYSTEM

• Cost of purchases is recorded in a purchases account (expense account)

• Freight In – freight cost paid
• Purchase Returns and Allowances – for goods returned and allowances
granted (contra-purchase account)
• Purchase Discount – is increased for full payment of accounts within the
discount period (contra-purchase account)
• Company does not maintain a running account of changes in the inventory.
At the end of the period, the quantity of goods on hand is determined by
conducting a physical count, and the cost of ending inventory is recorded.
 PERIODIC INVENTORY SYSTEM

Inventory, beginning xxx

Add: Net purchases* xxx
Total cost of goods available for sale xxx
Less: Inventory, end xxx
Cost of goods sold xxx

*Purchases xxx
Add: Freight In xxx
Sub-total xxx
Less: Purchase Discount xxx
Purchase Returns and Allowances xxx xxx
Net purchases xxx
INVENTORY VALUATION
 INVENTORY VALUATION

• The basic issues in inventory valuation include the determination of

1. the items to be included in the inventory
2. the costs to be included in the inventory, and
3. the cost flow assumption to be adopted.
 ITEMS TO BE INCLUDED IN THE
INVENTORY

• The basic criterion for including items in the inventory is economic control
rather than physical possession. Economic control is usually consistent with
the possession of a legal title.
 ITEMS TO BE INCLUDED IN THE
INVENTORY

1. GOODS IN TRANSIT
• Shipping terms to determine ownership:
a) FOB Shipping Point – the title passes to the buyer upon shipment
– buyer is responsible for paying the freight costs
– Freight In is recorded, added on the cost of goods
purchased by the buyer
b) FOB Destination – the title passes to the buyer upon receipt of goods
– seller is responsible for paying the freight costs
– Freight Out is recorded, considered as a selling expense in
the income statement of the seller
 ITEMS TO BE INCLUDED IN THE
INVENTORY

1. GOODS IN TRANSIT
 ITEMS TO BE INCLUDED IN THE
INVENTORY

2. CONSIGNMENT
• This is a trading arrangement in which a seller sends good to another entity who pays
the seller only as soon as the consigned goods are sold.
• The company delivering the goods, the consignor, retains control and ownership, while
the company receiving the goods, the consignee, attempts to sell them.
• Goods held on consignment by the consignee are excluded from the inventory of the
consignee.
 ITEMS TO BE INCLUDED IN THE
INVENTORY

2. CONSIGNMENT

Consignor Consignee
 SHIPPING TERMS

ILLUSTRATION:
Super Sale Club reported an inventory of P36,400 at December 31, 2020, end of its
fiscal year. It is discovered that the inventory amount included the following:
• Merchandise costing P3,700 ordered in December 22, 2020; shipped to the
company FOB Destination and arrived on January 2, 2021.
• Merchandise costing P4,800 held on consignment.
• Merchandise costing P6,200 ordered from a supplier on December 26, 2020;
shipped FOB shipping point on December 28 but had not yet arrived by December
31.
• Merchandise costing P5,900 ordered by a customer on December 27, 2020;
shipped FOB destination on December 29, 2020 for arrival at the customer’s
warehouse on January 5, 2021.
Compute the correct amount of inventory to be reported on December 31, 2020
statement of financial position.
 SHIPPING TERMS

Super Sale Club reported an inventory of P36,400 at

December 31, 2020, end of its fiscal year. It is discovered that
the inventory amount included the following: SOLUTION:
a) Merchandise costing P3,700 ordered in December 22,
2020; shipped to the company FOB Destination and arrived
Reported inventory P 36,400
on January 2, 2021. Goods purchased FOB destination (3,700)
b) Merchandise costing P4,800 held on consignment.
Goods held on consignment (4,800)
c) Merchandise costing P6,200 ordered from a supplier on
December 26, 2020; shipped FOB shipping point on Correct amount of inventory P 27,900
December 28 but had not yet arrived by December 31.
d) Merchandise costing P5,900 ordered by a customer on
December 27, 2020; shipped FOB destination on December
29, 2020 for arrival at the customer’s warehouse on January
5, 2021.

Compute the correct amount of inventory to be reported on

December 31, 2020 statement of financial position.
 COSTS TO BE INCLUDED IN THE
INVENTORY

• Philippine Accounting Standard (PAS) 2 prescribes that cost should include the
following:
• Costs of purchase (including taxes, transport, and handling) net of trade and cash
discounts received
• Costs of conversion (including fixed and variable manufacturing overheads)
• Other costs incurred in bringing the inventories to their present location and
condition
 COSTS TO BE INCLUDED IN THE
INVENTORY

• CASH DISCOUNTS
1. Gross Method – the purchase is recorded at the gross price; the amount of
discount is recorded only if the discount is taken.
2. Net Method – the purchase is recorded at its net price; the amount of discount
appears only if the discount is not taken (Purchase Discount Lost – other expense in
the income statement)

Trade Discounts – deductions from the list or catalog price in order to arrive at the
invoice price which is the amount actually charged to the buyer. Trade discounts are not
recorded.
Cash Discounts – deductions from the invoice price when payment is made within the
discount period. Cash discounts are recorded as purchase discount by the buyer.
 CASH DISCOUNTS

ILLUSTRATION:
Patient Retailers purchased merchandise with a list price of P150,000, subject to
a trade discount of 15% and credit terms of 2/10, n/30.
At what amount should Patient Retailers record the cost of this merchandise if
the a) gross method and b) net method is used?

SOLUTION: a)
Cost of inventory (150,000 x 85%) P 127,500

SOLUTION: b)
Cost of inventory (127,500 x 98%) P 124,950
 COSTS TO BE INCLUDED IN THE
INVENTORY

• PRODUCT AND PERIOD COSTS

1. Product costs / Inventoriable costs – these are the costs incurred to produce
or acquire units of inventory and are recorded in the inventory account.
Examples: Freight costs, and labor and other production costs
2. Period costs – costs charged to expenses
Example: Selling and general administrative expenses
 COSTS TO BE INCLUDED IN THE
INVENTORY

• VARIABLE vs. ABSORPTION COSTING

1. Variable costing / Direct costing – costing method that varies directly with the
production volume and is charged to products as manufacturing takes place.
2. Absorption costing / Full costing – costing method in which all manufacturing
costs, variable or fixed, direct and indirect, incurred in production are included in the
costs of the inventory.
Full costing is required by PAS 2.
 COST FLOW ASSUMPTION

SPECIFIC FIRST-IN, FIRST-OUT

AVERAGE COST
INDENTIFICATION (FIFO) METHOD
 COST FLOW ASSUMPTION

1. SPECIFIC IDENTIFICATION
• Specific costs are attributed to identified items of inventory.
• Used if there is a small number of costly, distinctive items are sold such as jewelries,
automobiles, and custom artwork.
 COST FLOW ASSUMPTION

2. AVERAGE COST
a) Moving-average method (perpetual system) – requires the computation of a
new average cost after each purchase.

b) Weighted-average method (periodic system) – determines the average cost

determined only once at the end of the period.
 AVERAGE COST

ILLUSTRATION:
Pinoy Shop, Inc. shows the following data relating to an item of inventory:
Inventory, January 1 100 units @ P58.40
Purchase, January 9 300 units @ P54.00
Sale, January 14 200 units
Purchase, January 19 90 units @ P60.00
Sale, January 25 140units
Inventory, January 31 150 units
Allocate inventory costs to the cost of sales and ending inventory using the:
1) Weighted-average method
2) Moving-average method
 WEIGHTED-AVERAGE COST

Total cost of goods available for sale P 27,440

Pinoy Shop, Inc. shows the following data relating to an Inventory, January 1 100 units @ P58.40
item of inventory: Purchase, January 9 300 units @ P54.00
Inventory, January 1 100 units @ P58.40 Purchase, January 19 90 units @ P60.00
Purchase, January 9 300 units @ P54.00 Divided by the total units available for sale 490
Sale, January 14 200 units Average cost per unit P 56
Purchase, January 19 90 units @ P60.00
Sale, January 25 140units Cost of Sales (200+140 units) @ P56 P 19,040
Inventory, January 31 150 units OR
Total goods available for sale P 27,440
Ending Inventory P 8,400
Cost of Sales P 19,040
Allocate inventory costs to the cost of sales and ending
inventory using Weighted-average method
Ending Inventory 150 units @ P56 P 8,400
 MOVING-AVERAGE COST

Pinoy Shop, Inc. shows the following data relating to an Jan Purchase Cost of Sales Balance
item of inventory:
1 100 @ P58.40 = 5,840
Inventory, January 1 100 units @ P58.40
9 300 @ P54 = 16,200 400 @55.10 = 22,040
Purchase, January 9 300 units @ P54.00
Sale, January 14 200 units 14 200 @ P55.10 = 11,020 200 @55.10 = 11,020

Purchase, January 19 90 units @ P60.00 19 90 @ P60 = 5,400 290 @56.62 = 16,420

Sale, January 25 140units 25 140 @ P56.62 = 7,926.80 150 @56.62 = 8,493.20
Inventory, January 31 150 units

Ending Inventory P 8,493.20

Allocate inventory costs to the cost of sales and ending Cost of Sales (11,020 + 7,926.80) P 18,946.80
inventory using moving-average method
 COST FLOW ASSUMPTION

3. First-In, First-Out (FIFO) Method

• Items of inventory that were purchased or produced first are sold first.
• Consequently, the items remaining in inventory at the end of the period are those
most recently purchased or produced.
 FIRST-IN, FIRST-OUT (FIFO) METHOD

ILLUSTRATION:
During June, the following changes in inventor item KDES took place:
June 1 Balance 1,400 units @ P24
8 Sale 400 units @ P50
10 Sale 1,000 units @ P40
14 Purchase 800 units @ P35
24 Purchase 700 units @ P30
29 Sale 600 units @ P44
Determine the COGS and ending inventory under FIFO method.
 FIRST-IN, FIRST-OUT (FIFO) METHOD

During June, the following changes in inventor item

KDES took place: Units Sold 2,000
June 1 Balance 1,400 units @ P24 Cost of goods sold P 54,600
8 Sale 400 units @ P50 1400 units x 24 = 33,600
10 Sale 1,000 units @ P40 600 units x 35 = 21,000
14 Purchase 800 units @ P35
24 Purchase 700 units @ P30 Ending Inventory (in units) 900
29 Sale 600 units @ P44 Ending Inventory (at cost) P 28,000
700 units x 30 = 21,000
Determine the COGS and ending inventory under FIFO 200 units x 35 = 7,000
method.
 EXERCISE

KDS Clothing sells jeans. During October 2020, its inventory records were as follows:

Beginning inventory 100 pairs @ P120

Oct 6, Purchase 40 pairs @ P125
Oct 10 Sale 50 pairs
Oct 15 Purchase 70 pairs @ P130
Oct 20 Sale 100 pairs
Oct 25 Purchase 40 pairs @ P130

Determine the ending inventory using a) weighted average, b) moving average,

and c) FIFO method.
 EXERCISE

ANSWER:

Ending inventory using a) weighted average, b) moving average, and c) FIFO

method.

A) P 12,520.00
B) P 12,710.75
C) P 13,000.00
 LOWER OF COST AND NET REALIZABLE
VALUE (LCNRV)

• Inventories shall be measured at the lower of cost and net realizable value
subsequent to their acquisition if their utility is no longer at par or lower than
their cost.
• Decline in value of the inventories may possibly be due to obsolescence, price
level changes, and damaged goods.
• Lower of cost or net realizable value is applied to an item-by-item basis or
individual basis.
 LOWER OF COST AND NET REALIZABLE
VALUE (LCNRV)

• Net realizable value

• Estimated selling price in the ordinary course of business less the estimated cost of
completion and estimated cost necessary to make the sale.
• Approximation of the market price or market value of the inventory.
 LOWER OF COST AND NET REALIZABLE
VALUE (LCNRV)

ILLUSTRATION:
Determine the carrying amount of proper unit inventory price in the following
inventory items by applying the lower of cost and net realizable value rule:

101 102 103

Cost P 8.10 P 10.50 P 12.20
Selling price 8.85 14.00 12.00
Cost to sell 0.90 1.50 1.20
Quantity in stock (units) 100 200 500
 LOWER OF COST AND NET REALIZABLE
VALUE (LCNRV)

Determine the carrying amount of proper unit Solution:

inventory price in the following inventory items Cost Inventory, end
NRV
by applying the lower of cost and net realizable (selling price
value rule: less cost to sell) (units x LCNRV)

Item 101 P 8.10 P 7.95 P 795

101 102 103 Item 102 10.50 12.50 2,100
Cost P 8.10 P 10.50 P 12.20 Item 103 12.20 10.80 5,400
Selling price 8.85 14.00 12.00 TOTAL P 8,295
Cost to sell 0.90 1.50 1.20
Quantity in stock 100 200 500
(units)
 RECORDING INVENTORY WRITE-DOWN

1. Direct Method
• This is the recording of the write-down of inventory cost to the net realizable value
directly in its inventory and cost of goods sold account
2. Allowance Method
• This is the recording of the market decline as an increase to a loss account and an
allowance account which is deducted from the inventory on the statement of
financial position.
• The allowance account must be adjusted each period.
PRESENTATION AND ANALYSIS
 INVENTORY TURNOVER

• Measures the average number of times a company sells inventory during a

given period.
• It measures liquidity of the inventory and evaluates the efficiency of a company
in handling the goods it manufactures or buys to sell.
• Higher inventory turnover means a company is more efficient and profitable.

஼௢௦௧ ௢௙ ௚௢௢ௗ௦ ௦௢௟ௗ

Inventory Turnover ൌ
஺௩௘௥௔௚௘ ூ௡௩௘௡௧௢௥௬
 AVERAGE DAYS TO SELL INVENTORY

• Determines the number of days funds are tied up in inventory.

ே௨௠௕௘௥ ௢௙ ௗ௔௬௦ ௜௡ ௔ ௬௘௔௥ ௢௥ ଷ଺ହ ௗ௔௬௦

Average days to sell inventory ൌ
ூ௡௩௘௡௧௢௥௬ ்௨௥௡௢௩௘௥
 INVENTORY INTERNAL CONTROL

• Internal control measures should be established to ensure that the inventory is

properly safeguarded. These may include the following:
• Clear lines of responsibility
• Effective record-keeping
• Segregation of duties between employees
• Insurance of key assets
• Adequate security systems
 PRESENTATION

STATEMENT OF FINANCIAL POSITION

Account Classification
Merchandise inventory Current assets
Supplies inventory Current assets
Raw materials inventory Current assets
Work-in-process inventory Current assets
Finished goods inventory Current assets
 PRESENTATION

INCOME STATEMENT
Account Classification
Purchases Cost of goods sold
Freight in Cost of goods sold
Purchase discounts Cost of goods sold
Purchase returns and allowances Cost of goods sold
Freight out Distribution expense
 PRESENTATION

DISCLOSURES
• An accounting policy for inventories
• Carrying amount, generally classified as merchandise, supplies, materials,
work-in-process, and finished goods.
• Carrying amount of any inventory carried at fair value less costs
• Amount of any write-down of inventories recognized as an expense in the
period
• Amount of any reversal of a write-down to the NRV and the circumstances
that led to such reversal
• Carrying amount of inventories pledged as security for liabilities
• Cost of inventories recognized as expense (cost of goods sold)
 END OF CHAPTER

Reference:
Salendrez, Herminigilda; Tubay, Jerwin; Paril, Alloysius Joshua; &
Menaje, Placido Jr. (2021). Basic Approach to Financial Accounting:
User’s Perspective (Revised Edition). C&E Publishing.